Friday, May 25, 2012

Has the Eurozone Already Fragmented?

The invaluable Gillian Tett raises an interesting question. Despite the enormous concern about the possible breakup of the euro, divorce proceedings may already be under way in the dark recesses of bank portfolios. Risk managers, preparing for an eventual collapse, have realigned their portfolios, Tett reports, so that assets are matched to liabilities. In other words, if a French bank has lent money to entities in Spain, the bank will have attempted to secure Spanish financing for those loan assets. Previously, this was not the case. A French bank might lend to Spain against short-term financing from Germany, say, or the United States. This promoted a free flow of capital and made financing of loans to the periphery cheaper and more plentiful, but also vulnerable to sudden stops and, in the event of a breakup and reversion to national currencies, currency risks. Under the new "asset-liability management," or ALM, procedures, this is no longer the case. In short, one of the benefits--a problematic benefit, as we have seen--of the euro, namely, cheaper capital for the periphery, has already been lost, a casualty of past irresponsible lending and intoxication with what, in principle, should have been a good thing.

3 comments:

There is, of course, another sense in which the zone is fragmenting. Although there is only one currency and one authority setting euro-area policy rates, there are big differences in monetary conditions from country to country.

We are presently in a situation where the risk of a break-up of the Euro is non-trivial. Thus banks become adverse to risk and do this sort of ALM.

Should fears of a Euro break-up abate, it is likely that this behaviour would gradually vanish. There is hope there as we know that banks go through cycles of easy and tight lending, including phases of exhuberance. Check out bank lending to South America since the early eighties.

The real problem today is the non completion of Europe without a form of political union allowing federalisation of government debt: The California bankruptcy does not matter to US credit because of the US political union, which includes rules on State deficits.

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I have been a student and observer of French politics since 1968. In that time I've translated more than 130 books from the French, including Tocqueville's Democracy in America and Thomas Piketty's Capital in the 21st Century. I chair the seminar for visiting scholars at Harvard's Center for European Studies and am a member of the editorial board of French Politics, Culture, and Society and of The Tocqueville Review/La revue Tocqueville. You can read some of my writing on French politics and history here and a short bio here. From time to time I will include posts by other students of France and French politics (accessible via the index link "guest"). My hope is that this site will become a gathering place for all who are interested in discussing and analyzing political life in France. You can keep track of posts on Twitter by following "artgoldhammer".